SG - M2 - Understanding the External Environment PDF

MODULE 2 UNDERSTANDING THE EXTERNAL ENVIRONMENT LEARNING OBJECTIVES After completing this module, you should be able to: 2.1 select the key concepts, factors and frameworks that relate to understanding the influence of the external environment on organisational strategy 2.2 evaluate the key factors related to external environment that impact growth, profitability and competition 2.3 appraise how the roles of management and leadership drive the organisational strategy in relation to the external environment. ASSUMED KNOWLEDGE It is assumed that, before commencing your study in this module, you are able to: explain strategic management explain the principles of governance and ethics describe the key tasks of financial accounting describe the overall strategic process, the contemporary business context and the role of leadership in strategy. PREVIEW In module 1, we identified the stages of the process used in the rational approach to strategy. These stages were explained in figure 1.4 and are shown again in figure 2.1. FIGURE 2.1 Strategy process: analysis of the internal environment Global strategy and leadership (Module 1) Strategic analysis: external environment (Module 2) Exploring Developing Implementation options strategy and monitoring Strategic analysis: (Module 4) (Module 5) (Module 6) internal environment (Module 3) Emerging business models (Module 7) Strategic analysis: Where are we now? Data collection Remote environment analysis Industry analysis Market analysis Competitive analysis We will systematically work through the strategy process stages in modules 2–6, beginning with the strategic analysis stage. Conventionally, a strategic analysis is undertaken annually with data captured and collected on a more regular cycle to be used in decision making. It is important to recognise that while strategic analysis is a discrete stage of the strategy model, the internal and external environments are constantly monitored to ensure the organisation is aware of and can respond to changes. This has become increasingly important and possible due to the increasing pace of change and complexity of the business environment and advances in the ability to collect and analyse data grown. We can separate strategic analysis into two main parts: analysis of those aspects outside or external to the organisation, and those areas within the organisation or the internal environment. The focus in this module is on understanding the external environment; module 3 considers the internal resources and capabilities of the organisation. To enable organisational leaders and managers to develop a strategy and direction for an organisation, an analysis of external and internal influences is required to determine their effects on the organisation’s performance. Each category of external and internal influences is illustrated in figure 2.2 (referred to as ‘the framework’), including the outputs of the organisation — the product or service that proceeds through a range of distribution channels to the end customer. This module provides concepts and frameworks for strategic analysis of the external operating envi- ronment of an organisation, including an exploration of how information technology can support this analysis. The main tools we consider are STEEPLE analysis, Porter’s five forces analysis, and competitive positioning, which are shown in figure 2.2. The major topics covered are: defining an industry evaluating an industry’s attractiveness using tools such as STEEPLE to assess growth, Porter’s five forces analysis to assess profitability, and the competitive environment to assess the competitive landscape of the industry considering the key issues that might affect the industry’s growth, profitability, competitiveness and sustainability analysing the data, gathering insights and integrating the expected effects these complex issues may have on the organisation’s strategy, since many issues are qualitative and subjective, rather than quantitative and objective. 70 Global Strategy and Leadership FIGURE 2.2 Framework for strategy analysis External business drivers Political, regulatory and legal environment, market characteristics, competition, substitutes, demand for services, increasing complexity, technological changes and advances, environmental factors, stakeholder expectations EXTERNAL INFLUENCES INTERNAL INFLUENCES Operational drivers Strategic drivers Markets/ Stakeholders Industries Products/ Channels Customers STEEPLE Internal and Services SWOT external BCG matrix Porter’s ﬁve forces Competitive People and organisational positioning drivers matrix Source: KPMG and CPA Australia 2020. The first challenge in undertaking strategic analysis is to define the scope of the external environment and industry to be analysed. This challenge extends to finding or sourcing meaningful data for analysis and considering its meaning and influence on the organisation. This data analysis informs the organisation effectively and efficiently about its current position and helps shape decisions about where it wants to be in the future. The external environment includes the specific industry the organisation competes within, its competi- tive position within this industry, as well as the broader macro-environment (i.e. the remote environment). It is important to understand that an external factor (e.g. changing foreign exchange rates) that has a negative effect on one industry may have a positive effect on another industry due to the nature of the organisations within that industry. It is also important to recognise the potential for an environmental factor (usually technology based) that has such a profound impact on the industry landscape that it creates a ‘disruption’. Disruptions change the market and value network within an industry, and have the potential to displace existing players (no matter their size and influence). Understanding both the remote and industry environments helps clarify what drives growth and profitability in the industry, identify how competitors are acting and create awareness of disruptive technologies. This analysis informs what an organisation needs to have in place to be competitive and successful in this operating context now and in the future. The organisation can then develop its strategic plan in the context of what is happening around it. Leaders and managers take an active role in the structure, development and implementation of the external analysis in order to optimise its relevance to the organisation by: providing insights into the type of forces that are most relevant to the industry and therefore should be assessed providing resources to enable the collection and analysis of relevant data being open to new ideas and initiatives derived from this analysis being prepared to make difficult strategic decisions to support these. 2.1 UNDERSTANDING THE EXTERNAL ENVIRONMENT It is important to differentiate between industry, market and the external environment of an organisation. Often these terms are used interchangeably; however, in this module, they broadly refer to the following. Industry is the grouping of similar economic or commercial activities. For example, the clothing retail industry is made up of all organisations that manufacture and/or distribute clothing. Market is the grouping of all organisations and their buyers. So the retail clothing market consists of the providers, listed above, and the consumers of these products. MODULE 2 Understanding the External Environment 71 External environment refers to factors external to the organisation that influence the organisation’s strategy, including but not limited to: industries and markets, societal issues, technological changes, economic drivers, environmental issues, political forces, laws, ethical considerations and a variety of other factors. In an analysis of the external environment, we are interested in identifying factors that will have led the industry to its current state and that are expected to affect its future growth and profitability. This analysis is an important foundation in strategy development, as the environment provides the context within which the organisation operates and competes. From this analysis it is then possible to define key success factors for the industry, which form the basis for understanding an organisation’s competitive position. By starting with the external environment in strategy analysis, leaders and managers are forced to look outside their organisation and consider issues that are not normally part of their day-to-day world. This results in a more critical analysis of the organisation in terms of how its strategy, stakeholders, capabilities and performance fit in the context of the external environment and how this fit may need to change and evolve over time. The analysis of the external environment is considered a difficult component of strategic analysis for the reasons listed below. Focusing on the corresponding questions may help you to navigate these. 1. Difficulties in framing the scope of analysis, including industry and market definition due to the breadth of the analysis required — what information do we need? 2. Difficulties in sourcing reliable data to analyse — where do we find this information? 3. Uncertain and ambiguous signals produced by the environment make interpretation difficult — what does it mean? 4. Focusing on the past may not help predict the future — what has changed? 5. Factors that have shaped the industry’s growth, profitability or competitiveness to date will not necessarily have the same impact on the industry’s future state — what is the impact of the change? 6. Many of the factors in external environment analysis are outside the control of the organisation and difficult to predict — what can we do to protect our organisation from external forces? 7. Often disruptive factors and technologies are not anticipated by organisations and thus their impact is not assessed and planned for and the organisation is caught off guard — is our competitive position sustainable in the long term? While leaders and managers can help frame the scope of external analysis based on their expertise and experience, they need to resist falling into the trap of believing that they already know all there is to know. Instead, they need to be open to the potential opportunities and threats that may be uncovered by the external analysis and be prepared to act on them, through strategic decisions that secure the organisation’s future growth and profitability. THE ROLE OF THE CPA IN ANALYSIS Data analysis, business intelligence, and ultimately advice and decision making, are at the core of analysis. It follows then that finance professionals such as CPAs are deeply involved in many aspects of the strategic analysis process. This involves both conventional financial and management accounting roles and increasingly responsibilities related to issues such as measuring social and environmental performance and shaping the organisation’s approach to data analytics. An essential part of the external environment assessment process is the analysis of financial and economic influences on the organisation and its operations. Engaging finance professionals (such as a CPA) to capture, collect and analyse the contribution of data to decision making improves the value and appropriateness of the analysis of that data for rigorous decisions. The STEEPLE, Porter’s and competitive assessments include key areas of analysis and the CPA regularly contributes to analysis of this type. The CPA is also qualified to offer judgement on analysis of industry sectors and the influence of economic drivers such as currency fluctuations and legislative changes such as taxation and superannuation rules may have on sectors and organisations. External analysis of market uncertainties and impact on risk, financial regulatory compliance, and economic impact is vital in ascertaining and forecasting for the future market landscape and understanding the causes and effects of those risks. Many functional areas and business units need to manage the level of tax liability undertaken in conducting business and understand that mitigating risk will improve a firm’s financial position and the converse is also true. Industry initiatives, acquisitions and new product development projects must be analysed while considering the financial implications and influence on the competitive environment, while monitoring competitor activities. The CPA is the most knowledgeable member of the planning team to conduct this assessment and advise at both an industry and organisational level. 72 Global Strategy and Leadership Financial metrics have long been the standard for assessing an organisation, market and industry performance. These traditional financial metrics report on the information recorded and processed in accounting or tax accounting systems in order to translate these into growth and profitability — ‘the language of money’ (Nikolaevich, Yurievna, Vladimirovich & Agüero 2019) — and are focused on the needs of shareholders. The CPA must be familiar with these metrics, the data that informs them, where to find this data and how to assess and measure performance against financial goals and metrics. In modern organisations, it is no longer reasonable to only consider shareholders in strategic decisions and reporting. More recent expectations require a broader approach where accounting information covers any information flows and data to all relevant stakeholders. Stakeholders are both internal (shareholders, employees) and external (customers, suppliers, community groups). Stakeholder analysis (discussed in module 3) assesses the relationship of the various stakeholders to the organisation, their relative position, their attitudes and expectations and how these may impact on profitability, performance and strategy. This approach integrates financial information with the information on the environment, society and governance and shapes the type of data that is gathered and how it is used. For example, many stakeholders are placing more importance on corporate social responsibility and sustainable practices. As a result, CPAs may need to report on emissions targets and offsets and even the payment of suppliers, etc. Other activities that may be reported on include resource conservation, environmental activities and initiatives, occupational health and safety, community relationships and the overall economic impact of the organisation. To adopt this approach, CPAs need to understand their stakeholders and their expectations and adapt their practices accordingly. These sustainability accounting and reporting practices identify and interlink the social, environmental and economic costs and benefits of an organisation’s strategies and actions and embeds them into future strategic decision making. EXTERNAL ENVIRONMENT ANALYSIS — ANALYSING AN INDUSTRY An industry analysis process considers factors that affect both the growth and profitability of an industry, which in turn will affect an industry’s level of competition. The process includes an understanding of: the definition of the ‘industry’ to be analysed, its value chain and its various segments the life cycle stage of the industry how the industry has evolved to its current state, and the key factors that have driven historical growth and profitability how the factors may change, and their impact on future growth and profitability what drives customer demand for the products and services offered by the industry the industry key success factors and how competitors in the industry compete any technological innovations that may create a significant disruption in the industry. A thorough analysis of these steps should enable us to draw conclusions about the relative position of an organisation in the context of current competitive factors in the external operating environment and how well placed it is to remain competitive in the future. Gathering Data for Industry External Environment Analysis We have already determined that some of the biggest issues in conducting an external analysis are as follows. 1. Difficulties in framing the scope of analysis, including industry and market definition due to the breadth of the analysis required — what information do we need? 2. Difficulties in sourcing reliable data to analyse — where do we find this information? Sustainable reporting practices have changed the scope of the information that needs to be collected, with environmental, social and governance issues playing an increasingly important role in strategic decisions. These factors also require new approaches to gathering information. When integrated into decision making, this is referred to as business intelligence (BI). There is now, more than ever, a vast amount of data available for organisations to consider. Technology means that more data is available to more people more often. Although this offers obvious advantages in external environmental analysis, it is not without risk. It is more important than ever to have a structured approach to BI. Clearly understanding what information, your organisation needs is essential to avoid an information overload and the potentially greater danger of ‘boiling the ocean’, where you are so overwhelmed by data, that rather than being enhanced, decision making is actually stifled. MODULE 2 Understanding the External Environment 73 Once the organisation has decided what information is needed, the next step is to decide where to find that information. Is it relevant, reliable and viable? Data comes in various different forms, including quantitative and qualitative, structured and unstructured. Recent technological advances have allowed for unprecedented combinations of these types of data. Big data is an all-encompassing term for the volume, velocity and variety of data that is now available. The majority of this data comes from three sources: social data — for example, likes, comments, and shares; machine data — for example, scanners, logs and tracking; and transactional data — for example, invoices and receipts. Big data is expected to rise exponentially with the growth of artificial intelligence and the Internet of Things. The nature and scale of big data means that it requires considerable resources and particular skill sets to make sense of it and gain the insights necessary for strategic decision making. As many organisations do not have these capabilities in-house, the collection and reporting of this type of data is often outsourced, creating a new expense. Big data analytics are technologies that have been developed to help organisations make sense of this vast amount of information. These services can be used to flag risks, benchmark an organisations’ activities relative to their competitors, monitor any reference to the organisation and analyse best practices. Consider social media analytics. The key benefit of obtaining search and social media data is that it is often a forward or leading indicator of customer behaviour and patterns. Issues or opportunities that analysts or organisations would previously have taken months to observe can now be identified much earlier. A powerful example is the ability of health departments to identify potential disease outbreaks earlier by tracking searches for particular symptoms rather than waiting for collated data from hospitals, which could take weeks or even months to report. This early knowledge can lead to substantial savings in healthcare management. Analytics can also be used in a materiality assessment to identify the most relevant issues for their sustainability strategies. Traditionally, stakeholders would be approached by a member or agent for the organisation to gauge their expectations. This is a resource and time-consuming exercise. Analytics such as datamaran can be used to review multiple sources such as company report, news and social media sites that act as proxies for stakeholder groups. It tracks the amount of space given to each topic and the context in which it is mentioned. It can then offer insights into concerns in the industry or market, competitor or supply chain issues, changes in the regulatory environment and stakeholder attitudes and behaviours offering a more comprehensive and large-scale materiality assessment than can be done through traditional methods. The risk to the organisation is choosing the best and most relevant analytics for their situation. In order to ensure best ‘bang for your buck’, it is more important than ever for the leaders and managers to be clear on what information they need and why. Developing a BI methodology should not be an ad-hoc exercise. Instead, organisations should adopt a structured approach, which combines internal data collection, storage and collation and the procurement of external research from subscription-based services that provide collated statistics, share-analyst pre- dictions, industry reports, online analytics and third-party data management services. The following list includes some sources for gathering information about an industry and the external environment in which it operates. Public agency and statutory authority reports from organisations that are rigorous in publishing accurate data. Statistics produced by government departments are a reliable source of information. Two Australian examples are the Productivity Commission and the Australian Bureau of Statistics (ABS). Commercial research from private research companies, such as IBISWorld, that collate a large amount of publicly available information and combine it with their own analysis to prepare succinct summaries of specific industries and companies. Reports of trending topics and purchased data and analysis of social media discussions from external providers. Many industry associations collect statistics and monitor project trends, although some of this infor- mation is available to members only. Market research firms investigate sociocultural attitudes, both specifically and generally. While much of this information may be a couple of years old, this is generally not a problem as the analysis focuses on understanding trends. Public company annual reports, analyst presentations and initial public offering (IPO) documents can prove a valuable source of information on an industry and the forces affecting it. In particular, IPO documents provide a good summary of what factors the company’s directors believe will affect growth and profitability in the future as these forms the basis of the company’s forecast financials. Lobbying organisations monitor political trends and the specifics of planned legislation. 74 Global Strategy and Leadership Universities are repositories of research information and employ researchers who are looking for real- life problems to address. Consultancy firms often issue industry updates in areas where they have consulting business. Up-to-date and accurate industry information is also embedded in investor briefings that listed companies make to the market. With so many options, it is becoming more and more difficult for organisations to decide the most relevant data to collect and the most viable sources. The smaller the organisation, the more likely it is to rely on publicly available industry and market information. Larger businesses are more likely to commission third parties and/or undertake their own research to ensure they have reliable and up-to-date information for decision making, as quality industry information is a powerful investment in risk management. In either situation, the organisation will often need to reformat or restructure data so that it can be manipulated and analysed effectively. The organisation may also need to make some assumptions. In preparing analyses of industries in Australia, similar markets can be observed. For example, the agricultural industry in New Zealand could be considered a close proxy in many respects to the agricultural industry in Australia. Where information on an industry is not available locally, it is acceptable to make intelligent assumptions — as long as the assumptions are explicitly stated. Strategic leaders and managers need to consider how their organisation will manage this increasingly complex and dynamic information landscape. Many organisations today are taking a cross-functional approach to this, with input from marketing, finance, legal, operations and other relevant functions as to their data and reporting requirements. Organisations with strong technical capabilities can utilise these in the procurement of data. New functions and industries have also evolved around data management and are another option to be explored. Some organisations hire internal ‘data curators’, who are responsible for matching data requests from throughout the business to the most relevant and reliable sources. Alternately, a slew of third-party data and consulting services have emerged and can be contracted to help organisations navigate the minefield of data available and optimise their BI systems. It is important to note that although these third-party suppliers have capabilities and expertise in data management, and may even have some industry insights, organisations need to work in partnership with these services, providing the input and strategic direction which guides the data collection and presentation. The success of organisational strategy depends heavily on the quality and utilisation of their environmen- tal research. Organisations need a well-planned approach to data collection, storage and use in order to keep up with changes in the broader economy, their specific industry and stakeholder behaviour. Developing a quality BI system enables the organisation to answer the initial questions of, what information do we need, and where do we find this information? Once collected, the data needs to be presented to clearly show what has changed in the industry/environment and the impact of that change on the organisation. IT is increasingly being used in gathering, collating and presenting the data, and understanding the availability and use of these techniques is an essential role for the BI coordinator. The quality of the research presented allows for true insights be gathered, and strategic decisions made on how to protect the organisation from external forces (where possible) and ensure a sustainable competitive advantage. Example 2.1 provides an overview of the fisheries industry and describes how advanced analytics can be used to support the industry to make more informed decisions. EXAMPLE 2.1 Advanced Analytics in the Fisheries Industry The fisheries industry is significant to the economies of many countries. Ensuring that the industry remains sustainable is essential to its long-term viability. There are a number of sectors that need to work together in order to make this happen, each with competing motivations. Demand for seafood has increased an average of 3.2% annually between 1961 and 2016 and is predicted to increase by 20% from 2016 to 2030. This increase is driven by global population growth, the expansion of the middle class and greater urbanisation (giving more people more access to seafood, as well as the electricity and refrigeration needed to store it). On the other hand, consumption of terrestrial mammals has risen by only 2.8%, representing a change in consumption patterns as more people are choosing fish as a good alternative to red meat. As demand continues to increase, fishing companies are putting unprecedented pressure on marine environments and ecosystems. In order to manage reduced hauls in traditional fishing areas, fishing MODULE 2 Understanding the External Environment 75 companies are expanding their footprint in the ocean as well as targeting new species. As a result, 90% of the world’s oceans are now fished commercially and about half of the world’s fish populations are classified as collapsed, rebuilding or overexploited (see figure 2.3). Balancing fishery interests with environmental concerns is a continuous challenge. Advanced analytics (AA) may provide a solution to this problem by using sophisticated methods to collect, process and interpret big data. FIGURE 2.3 Nearly half the world’s fish stocks are overexploited, rebuilding or collapsed Status of global wild-ﬁsh stock, % 100 Underexploited 75 Fully exploited 50 Overexploited 25 Rebuilding Collapsed 0 1950 1960 1970 1980 1990 2000 2010 Source: McKinsey & Company. Fishing is not the only threat to the sustainability of this industry. It is predicted that by 2025, there will be 250 million metric tons of plastic in the ocean — one ton for every three tons of fish! Coupled with this are the effects of climate change — acidification, warming and deoxygenation processes — which will have a profound impact on all marine ecosystems. These are global issues with many stakeholders involved in their management. In response to these varying issues, some countries and regions have already taken action to improve their fisheries management. For example, 69% of stocks managed by the Australian Fisheries Manage- ment Authority were sustainably fished in 2015. However, these measures are negated by unsustainable practices in other markets. However, regulation alone cannot eliminate overfishing and both national and international collaboration is needed to ensure a sustainable industry. Technology has enabled data to be collected and made available globally on issues such as catch reporting, trade-information sharing, subsidies, tariff policies and regulation enforcement. Advanced analytics can then be used to manage this data and make them meaningful to all stakeholders. Figure 2.4 describes how both fisheries and seafood consumers can benefit from AA. FIGURE 2.4 Potential use for AA in the fisheries industry Advanced analytics is... driving improvements... and creating benefits now more viable because of... for fisheries with... for seafood consumers with... Increased data availability through Better decision-making Increased sustainability of the sensors, satellite imagery, cameras, tools to achieve complex and world’s fish stocks, which will drones, and other technologies sometimes conflicting goals, improve global food security and Better tools for deploying and such as profitability and maintain the economic and communicating information, such as sustainability social benefits of fisheries smartphones and the Internet of Things New tools that address More efficient monitoring, biological variability, capture control, and surveillance Improved data-ingestion capabilities uncertainty, and manage instruments, which will reduce resulting from machine learning, artificial revenue volatility and risks illegal fishing (as well as the intelligence, better data storage, poor labour conditions and increased computational power, and Better methods for reporting human-rights abuses often other technological advances to public authorities found at companies that engage in such practices) Source: McKinsey & Company. 76 Global Strategy and Leadership There have been a number of key developments relevant to fisheries which include: 1. sensing platforms via satellites, drones and onboard or underwater devices 2. improved data-transmission technologies 3. more insightful data analysis. Data Acquisition Through Sensing Platforms Sensors for collecting data have become more common, compact and cost effective in recent years and the information gained from these have become freely available through a number of public agencies. The types of sensors and their relevance to fisheries include the following. Satellite optical and radar sensors. Optical sensors measure sea temperature and turbidity, while radar sensors measure ocean topography, winds, sea ice and the movement of vessels. Drones cover a smaller area than satellites, but provide more detailed images. Onboard or underwater devices record exhaustive and reliable data on vessel location, gear types and catch, species, volume, biophysical characteristics and discards. Some authorities require large fishing vessels to be equipped with these systems. Improved Data-Transmission Technologies Technology has enabled data collected from any of the above devices to be easily transmitted for analysis. This data can now be collected in real time via wireless mobile networks and satellites. More Insightful Data Analysis More powerful software and tools have meant that more detailed information can be recorded in real time. Also, the rise of artificial intelligence and machine learning has increased the scope and power of data analysis, enabling the identification of hidden relationships in large amounts of data. Advanced analytics are now being incorporated into all parts of the value chain with a variety of actions being taken at each stage as seen in figure 2.5. FIGURE 2.5 The adoption of analytics in fisheries requires a shift to data-informed, tech-enabled processes Key operational process From To Fisheries Data-scarce vision of fisheries based A data-rich environment that provides management on landed catches and observer data more reliable assessments Static management with yearly stock Dynamic management in which fishing assessment stock is continually assessed Detection and Detection driven by intuition, Detection supported by high- capture experience, and short-range or resolution models and daily forecasts immediate observations over the entire fishing territory Navigation according to experience Internet of Things sensors that monitor navigation parameters, helping to define the most optimal routes and energy-efficient navigation strategies Low visibility on net contents Automatic and continuous detection of catch parameters, such as fish size MODULE 2 Understanding the External Environment 77 Processing Manual catch sorting Automatic scanning and control of seafood-product quality through cameras and intelligent sorting systems Reporting Recording of captured species and Reporting assisted by onboard camera their biological parameters and artificial-intelligence recognition via logbooks software Surveillance and Surveillance based on partial and Real-time vision of fishing activities control uncertain information about that assist with the design of efficient fishing activities surveillance plans Lack of transparency because of the Decentralised and reliable information- multiple stakeholders involved management systems requiring little human intervention Few certification bodies to guarantee New sources of data that identify sustainability and conduct regular violations in almost real time reassessments Source: McKinsey & Company. The data being collected above can then be used to address a number of issues in the industry: 1. monitoring illegal, unreported and unregulated fishing 2. improving the detection of fish 3. reporting to authorities and management 4. enabling traceability. Monitoring Illegal, Unreported, and Unregulated Fishing AA can identify a fishing vessel’s activities and location to show whether they are in a restricted zone and whether they are actively engaged in fishing or carrying out other (potentially illegal) activities. Improving the Detection of Fish AA provide a more dynamic, reliable view of the ocean environment including fish aggregation and migration, temperature change, wave height, sea ice and other ocean conditions. This information coupled with vessel location and catch can help determine the distribution and migratory patterns of target species to aid in resource management and improve overall efficiency. Reporting to Authorities and Management AA automates the process of monitoring and reporting fishing activities. This is not only more time efficient but also leads to more exhaustive and reliable data. Traceability Transparency and traceability are becoming more and more important in all industries as consumers choose to be more informed about all aspects of the items and companies they are involved with. The fisheries industry has traditionally struggled in this area as many stakeholders have a culture of closely guarding their information, leading to corruption within the industry. AA and similar technologies can be used to track seafood all along the supply chain, allowing for unprecedented transparency and labelling that will help consumers make a more informed decision about their seafood purchase. These actions show how AA are being used in the fisheries industry. However, many stakeholders are still not using them to their full advantage. The greater affordability of the technology and availability of the data collected means that all stakeholders have the ability to either implement or use AA to improve their own operations and improve the efficiency and sustainability of the entire industry. Source: Exhibits from ‘Precision fisheries: Navigating a sea of troubles with advanced analytics’, December 2019, McKinsey & Company, www.mckinsey.com. Copyright © 2020 McKinsey & Company. All rights reserved. Reprinted by permission. QUESTION 2.1 Consider example 2.1. Evaluate and explain the value of analytics to improve performance and sustainability outcomes for the following stakeholders in the fisheries industry: 1. fishing companies 2. government agencies 3. food companies. 78 Global Strategy and Leadership The key points covered in section 2.1 of this module, and the learning objectives they align to, are as follows. KEY POINTS 2.1 Select the key concepts, factors and frameworks that relate to understanding the influence of the external environment on organisational strategy. The external environment refers to factors external to the organisation that influence the organisa- tion’s strategy, including industries and markets, societal issues, technological changes, economic drivers, environmental issues, political forces, laws, ethical considerations and other factors. The external environment is the context in which the organisation operates and competes. Industry analysis seeks to identify factors that have led to the industry’s current state and that will affect its future growth and profitability. This enables key success factors to be identified and thus informs the organisation’s strategic options. Analysis of the external environment increasingly involves large volumes of unstructured data. Organisations require a structured approach to using this data to ensure decision making is enhanced. Advanced analytics enable the use of big data to better inform decisions. 2.3 Appraise how the roles of management and leadership drive the organisational strategy in relation to the external environment. Leaders and managers use their experience and expertise to frame the scope of the external analysis, but must be open to recognising and responding to unexpected opportunities and threats. CPAs play an important role in analysis of the external environment and the provision of information and advice that informs the development of strategy. Leaders and managers must clearly communicate what information they need and how it will be used. 2.2 DEFINING THE INDUSTRY FOR ANALYSIS It is important that any strategic analysis begins by defining the industry in which the organisation operates. However, a key practical problem that often occurs in strategic analysis is that the people involved fail to agree on a definition of the industry within which their organisation operates and that they wish to analyse. Another problem is the omission of industry analysis entirely and focusing only on the organisation itself. In addition, an industry is sometimes defined by the purely practical factor of ease of access to quality and reliable data on which to base the analysis. We define ‘industry’ as a group of organisations or business units participating in similar economic or commercial activities, producing similar products or services. When thinking about industry from the viewpoint of a specific organisation, the definition of ‘industry’ should also include a geographic element (e.g. Australia, Asia–Pacific, Canada). This leads to tighter scoping of the analysis and clearer thinking about the organisation’s real competitors. An organisation like Guzman y Gomez, which operates Mexican- style fast-food restaurants, operated entirely in Australia for its first seven years. During that time it would confine its industry to take-away food in Australia. However, once Guzman y Gomez decided to target international expansion into other geographic markets, an analysis of the fast-food industry in the potential market was required in order to understand the industry in that country, its competitors, and so on. Hence, the company expanded its industry analysis to Singapore, then a couple of years later to Japan and recently to the United States. The concept of ‘industry’ is actually defined by the firm in the competitive market the firm sees itself operating in. For instance, a global computer software supplier might define itself as being in the ‘global software’ industry. A specialist software company supplying retail management systems in Australia might define itself as being in the ‘Australian retail computer software manufacturing’ industry. These organisations might compete with each other on occasion (such as in Australian retail software marketing), but each has quite a different view of the ‘industry’ in which it operates. These differing wide and narrow definitions are both very reasonable views about industries. A narrow definition may make analysis more manageable, but a definition that is too narrow may exclude relevant products or services, geographic regions, substitutes or disruptive influences. A wide definition of the industry can help avoid these issues, but will make analysis more time-consuming and difficult. These wide and narrow views are illustrated in figure 2.6. MODULE 2 Understanding the External Environment 79 FIGURE 2.6 An example of the wide and narrow definitions of ‘industry’ Global software Firm Australian retail computer software manufacturing Source: CPA Australia 2020. For instance, an analysis of the ‘global software’ industry includes all organisations producing any kind of software wherever they operate in the world — clearly a much more complicated analysis than if the focus were on only those firms that produce software in Australia. However, this wider definition minimises the risk of missing new trends, which often come from new entrants and substitutes. A narrow definition, such as the ‘Australian retail computer software manufacturing’ industry, makes it much easier to analyse, but also increases the likelihood that new trends may be missed, especially those developing in overseas markets. For example, many bookstores closed because of rising online book purchases and the move to e-readers, tablets and e-books. Many bookstores did not include online sales in their definition of their industry, thereby noticing the trend too late to recover. The same can be said for the Blockbuster video rental chain. They believed they had an unbeatable position within the home entertainment industry and completely underestimated the impact streaming services, such as Netflix, would have on their future viability. Within just a few years, Blockbuster went from an expanding multinational operation with billions of dollars of revenue to bankruptcy and liquidation. Ironically, Blockbuster had turned down the opportunity to purchase Netflix for just US$50 million in 2000. It can be very tempting to define the scope of an industry narrowly in geographic terms, especially if the majority of an organisation’s sales are based in that region. The potential pitfall here is that competitors from outside this region may have included your region in their industry scope. If that is the case, you will be on their radar, but they will not be on yours. You could miss an important industry development or move, purely because of how the industry being analysed has been narrowly defined. Similarly, an industry definition can sometimes be too focused on what is being produced now, and in doing so fails to recognise the overarching customer need that is ultimately being satisfied with the product or service. Such an oversight can have drastic consequences for an organisation. For example, the automobile industry long ignored inputs from environmentalists, scientists and politicians advocating the need to develop the use of alternative energy sources. Many automobile companies overlooked this need to consider the societal context of their products, and now find themselves perceived as a symbol of rampant energy consumption. Additionally, the industry needs to be viewed in the context of customer groupings so that each target market can be identified and a strategy developed accordingly. Some companies have very few competitors globally and it is therefore quite appropriate to define the industry as being global. These companies are often characterised by high barriers to entry (barriers to entry are discussed in more depth later in this module), limited markets for what they produce and proprietary know-how (such as patents). For example, Cochlear is an Australian company with 60% world market share for implants that enable severely deaf people to hear (Intelligent Investor 2018). It spends approximately 13% of its revenue of more than AU$1.4 billion on research and development (R&D) (approximately AU$180 million) to protect and improve its technology and stay ahead of competitors (Cochlear Limited 2019). It only has two main rivals, the Advanced Bionics Corporation in California (a unit of Boston Scientific Corporation) and Med-El Corporation in Austria, as well as a number of smaller competitors around the world. Cochlear must think about and define its industry on a global scale. It is important to note that there is no ‘right’ or ‘wrong’ way to define an industry. The definition simply determines what information is analysed under each particular heading. Under a narrow definition of the industry, competing products or services from outside that definition are not ignored, but can be handled as 80 Global Strategy and Leadership substitutes or new entrants in the industry analysis framework, which we will discuss later in this module. The important issue is to be consistent throughout the analysis. Typically, a CPA will work in an organisation that has a clear idea of the industry (and markets) within which it operates. As you work through this module, you will note that all industries change over time. However, the industries that prosper in the longer term are those that are perceptive enough to recognise the changes taking place in their environment and markets, and have the capabilities to put in place strategies to respond to these changes. The challenge for strategic leaders is to be open to shifting parameters in regard to the industries in which they operate. QUESTION 2.2 Consider the table below and identify the industry each organisation would be associated with. Organisation description Industry Ride-share operator Subscription air travel service Provider of ‘smart’ technology for household devices Vegan restaurant Vegetarian clothing manufacturer Car parts manufacturer R&D facility IT service THE INDUSTRY VALUE CHAIN Having considered the industry definition, the next step is to determine the position of the industry in the industry value chain. The value chain for an industry comprises the business processes, people, organisations, intellectual property, technology and physical infrastructure that transform raw materials or talents into finished goods and services, which are offered and distributed to the consumer to satisfy demand. For service industries the value chain concept is the same, but rather than converting a physical product it could be the conversion of ‘know-how’ into a format, such as advice that is offered to clients. Understanding the value chain is an essential part of analysing and understanding an industry. Different industries have different value chains, and each stage of the chain can comprise a number of competitors, each of whom may have operations in one or more stages of the chain. It is important that an organisation understands where it is positioned in the value chain, and what activities are taking place both upstream and downstream from where it is positioned. Again, as with the definition of industry, there are no wrong or right answers to defining an industry’s value chain. A generic value chain is shown in figure 2.7. It shows how a raw material can progress through the value chain, finishing with sales to the end consumer. FIGURE 2.7 A generic value chain Supply Demand Raw Logistics Sales to Raw Product material Purchasing Manufacturing and Merchandising end materials design processing distribution and retailing consumer Upstream Downstream Source: CPA Australia 2020. MODULE 2 Understanding the External Environment 81 Example 2.2 includes a value chain constructed for the fresh food industry. EXAMPLE 2.2 Fresh Food Industry Value Chain Figure 2.8 is a value chain for the fresh food industry. Once the value chain is agreed upon, it is much easier to understand and assess the future opportunities that the industry might offer or any aspect of the value chain that might require further education and training. FIGURE 2.8 A value chain for the fresh food industry Food service Mass retail Inputs (pesticides, Farming Packaging Distributing Consumer labour) Grocery Land Milking Selection Road Soil Feeding Packing Rail Exporting Climate Dipping Cutting Sea Water Seeding Labelling Air Drainage Harvesting Size Ploughing Load Fertilising Spraying Source: CPA Australia 2020. The value chain in example 2.2 has been broadly applied to the fresh food industry around the world; however, it can also be narrowed down to focus on a particular region and its specific geographic value chain. Individual organisations can be much more targeted about their industry value chain, building a value chain that is specifically targeted to their activities and operating context. This also includes deciding on locations around the world where components and activities of the value chain may be carried out. A key proposition of value chains is that new ‘value’ is created at each stage of the chain from the activities and processes undertaken in that component of the chain. Value is typically judged from the traditional perspective of economic value — that is, value created by taking a resource or set of inputs, providing additional inputs or processes that increase the value of those inputs, and thereby generating a product or service that has greater market value in the next component of the value chain. Measures of economic value creation have been refined over centuries, resulting in a host of performance measures, including return on investment, debt–equity ratios, price–earnings ratios and numerous others. 82 Global Strategy and Leadership QUESTION 2.3 Draw a value chain that shows the main activities in the value chain for coffee. In your diagram, consider the following. What are the inputs? What processes are involved? What products are made? How are they distributed? Consider the simplified production value chain for a pair of fine-wool trousers shown in figure 2.9. FIGURE 2.9 A value chain for a pair of fine-wool trousers Estimated returns Dirty Wool Woven Yarn = Trousers = per kg at each stage wool= tops = fabric = @$28/kg @$700/kg of the value chain @$7/kg @$11/kg @$70/kg Design, Cost process at Scouring, garment Sheep each stage of the Shearing carding and Spinning Weaving making, farming value chain top-making retailing etc. Source: Adapted from R Wallace & P McSweeney, 2006, Case Study 1: Supply Chain Innovation 1, Australian Wool Education Trust, Sydney, figures 1 and 4, pp. 4, 7, www.woolwise.com/AWET_Resources/Case_01_Supply_chain_innovation.pdf. It can be seen from figure 2.9 that the cost processes at each stage of the value chain result in increasing returns per kilogram at each stage of the industry’s value chain. At the same time, however, the quantum of investment (and therefore risk) for the organisations operating in the various value chain components also experience increasingly higher costs as the chain progresses towards product or service consumption. The capital investment in textile processing machinery for processes such as spinning and weaving is very high, as are the costs associated with, for example, brand creation and maintenance. It is easy to see how the initial AU$7 per kilogram of wool transformed to a AU$700 per kilogram pair of fine-wool trousers that retailed for AU$200. However, what is less easy to see and understand are the costs and risks associated with the value chain processes undertaken between these two end points — this is a common complaint of the producer of the initial raw materials who thinks they are being exploited by those involved in the later stages of the chain. As you will see later in the module, this could in fact be because the initial suppliers of the raw, dirty wool simply have low supplier power. Value chains for different industries take varying amounts of time and investment. For example, new drug development takes much longer and requires significantly more investment — estimated at 15 years and up to several billion dollars — than the manufacture and sale of a pair of woollen trousers. Profes- sional services organisations offer a number of technical services to assist in improving the customer’s operational and organisational performance. As shown in figure 2.10, the value chain can be similarly applied to the supply of services as it is to the manufacturing and supply of products. Where, in manufacturing, the supplier takes wool and ‘adds value’ to eventually produce a pair of trousers to satisfy consumer demand, service industries add value with knowledge sharing, time and personal skill sets. Professional services are often provided by a team of various people, all of whom undertake differing tasks. The value chain is based on activities that the service providers undertake in order to deliver their particular service. The list beneath each activity shows the particular tasks which add value to the activities and in turn, the customer. Collaborating with the whole team and discussing the most value-adding activities will assist in creating the most accurate value chain. MODULE 2 Understanding the External Environment 83 FIGURE 2.10 A professional services value chain Identify Deliver Maintain Develop Sell service Close the target service client proposal to client account client product relationship Conduct Discuss and Meet with Fulﬁl Make ﬁnal Follow up with research identify client client to obligations changes as per client six Identify client needs discuss set out in client request months on in need of Propose single concerns or statement Hand over Identify any assistance or numerous questions of work deliverables other areas of solutions Develop Work Hold a closing inefﬁciency or Approach client Organise contract terms collaboratively meeting with requiring professionally client service fair to both with client client and assistance through any prior team to the parties Respond to service team On-sell further satisfaction Clearly set out client needs services relationship/ contacts of client budget and Implement any Prepare timelines required change proposal for client information sharing Source: CPA Australia 2020. Ideally, returns for each component of the chain should be similar (e.g. for every dollar invested there is a similar return on investment for each component of the chain). Benefits need to be experienced and shared by all of the components in the chain, or the chain could become dysfunctional and inefficient. However, in reality, the forces of competition in a global industry mean that this is not always the case. Example 2.3 illustrates how the value in a chain can move between components over time, and this is influenced by the interplay of myriad complex factors. Where limited or reducing value is being experienced by any component in the chain, competitors in that component of the chain either go out of business or switch to alternative enterprises if they can. Generally, the unique capabilities required to be successful in each component of the value chain provide a protection mechanism against being subsumed into the previous or subsequent component of the chain. Where this is not the case, that component of the value chain is likely to cease or be absorbed by organisations active in upstream or downstream components of the value chain through vertical integration. For example, the wholesaling function in many value chains has suffered in recent years because this capability is not seen as being particularly difficult to acquire and does not add significant value to either manufacturers or retailers. Apple has opened up various channels for product sales, specifically focusing on retailing at Apple stores, where the experience of the store draws in customers, reducing customer demand at Apple distributors. Although Apple remains as a wholesaler to other retailers, it closely manages these retailers through tight pricing and margin controls to avoid any competitive pricing. The decline in wholesaling has been compounded by the trend for large wholesaler customers to seek to purchase directly from manufacturers, thus saving some of the costs and capturing some of the profits associated with the wholesaling function. The bricks-and-mortar retail industry has had to compete with online stores, which have few overhead expenses. One way this has occurred has been by purchasing products straight from the designer, as opposed to using agency and wholesale providers. For example, after suffering financial hardship and minimal profits, major retailer Kmart Australia now sources the majority of its stock directly from the manufacturing source, entirely eliminating the ‘middle-man’ suppliers and distributors. Children’s wear and intimate apparel have seen price reductions of up to 50% as a result of this direct sourcing strategy, passing on price cuts to customers while attracting more customers and increasing revenue. (You will note further in this module how the concepts of an industry value chain are linked to the factors that drive industry profitability.) Consequently, while a value chain can be drawn as a simple series of components, in reality the interrelationships are complex and each component represents an ‘industry’ in its own right. Example 2.3 illustrates aspects of this in relation to the value chain for the pharmaceutical industry. 84 Global Strategy and Leadership EXAMPLE 2.3 The Global Pharmaceutical Value Chain The value of the global pharmaceutical industry in 2018 is estimated to be greater than $AU1.1 trillion and has grown at an annual growth rate of more than 4.5% over the last four years. It is estimated that the rate of growth will accelerate over the next five years due to a significant boom in spending from emerging countries such as China, reaching a total value of $AU1.4 trillion by the end of 2023. Geographically, the United States, China and Japan are the largest markets, followed by Western Europe (Market Industry Profile 2019). The number of medicines available has steadily risen over the last century. At the present time there are over 1000 medicines under development, with companies investing large proportions of their revenue in R&D, the primary driver of competitiveness in the industry. Figure 2.11 shows a value chain for drug discovery. FIGURE 2.11 A value chain for drug discovery Illustrative Manufacturing Distribution Dispensing of drug R&D manufacturing Medicine acquisition Medicine costs Handling & delivery acquisition Import duties and Obsolescence costs Labour, facilities, Cost incurred taxes Capital costs equipment Promotion and Promotion and Medicine wastage education education Capital costs Education Innovation Ensuring continuous Medicine Regulatory medicine supply availability documentation Waste management Pharmacist advice Value added Quality assured Order processing Patient manufacturing Education convenience Education Additional health services Source: M Aitken, 2016, ‘Understanding the pharmaceutical value chain’, Pharmaceuticals Policy and Law, 18, pp. 55–56. In the drug development value chain, there is really only one valuable product: the drug or vaccine that the patient takes. The majority of promising molecules (called leads) never make it through testing. Research, testing and delivery have defined the industry’s value chain since the industry started, and the major pharmaceutical companies generally participate in each of these activities, either directly or, in the case of research, often through partnerships with research organisations, such as universities. There is significant cost associated with these activities, from drug discovery to testing and clinical trials, the submission of applications to regulatory agencies as well as promotion and education to stakeholders. The ‘reward’ for incurring these costs is a ‘grace period’ where the original manufacturers enjoy exclusive access to the market (through patents). Once the patent expires, other manufacturers can produce generic products based on the original. As they have not incurred the front-end costs, their manufacturing costs are much lower, resulting in lower prices. The value they add is to provide competition in the marketplace and access to price-sensitive consumers. The distribution of pharmaceuticals is largely carried out by importers and wholesalers. They act as conduits between the manufacturers and the retailers to ensure continuity of supply. It is a complex distribution process with a variety of products, from many manufacturers to a number of pharmacies, often requiring short timeframes and passing rigid handling standards. Distributors are then subject to warehouse costs, retail credit cycles and currency fluctuations. Retailers are tasked with dispensing the right drug, to the right patient, at the right dosage. Other value added at this stage include, labelling, advising and educating the consumer on the correct use of the drug. Many pharmaceutical companies and even countries are now trying to capitalise on the value that each stakeholder is already bringing to the healthcare system, and exploring how efficiencies can be gained in the overall system. For example, increasing costs for R&D have compelled major pharmaceutical companies worldwide to outsource part of their research and manufacturing activities to lower-cost, developing nations such as India and China. A further trend is that in recent years, smaller pharmaceutical companies in Asia, particularly in China, South Korea and India, have been able to successfully undertake MODULE 2 Understanding the External Environment 85 some components of the drug discovery value chain due to their ability to retain their cost advantage while matching the quality standards of the more mature manufacturing countries. The drug development process today has a sequence of rigorous and highly defined stages subject to stringent rules and regulations that enable progression to the next stage. These ‘rules’ can vary across different geographic jurisdictions, and there are significant efforts to ‘harmonise’ these rules and regulations around the world. The aim is to develop global policies that strike a balance between preserving the viability of each component in the value chain and making medicines available and affordable to patients. Globalisation of value chains adds a level of complexity when the components of the chain may be carried out in different parts of the world. Multinational and global organisations often organise for different functions in their own internal value chain to be carried out at different locations around the world, taking advantage of differences in factors of production in those locations. Consider the automotive industry, for example, where engines may be manufactured in one location, car body parts in another and so on. Similarly, industry value chains can be organised in multiple configurations. The textile industry was one of the first industries in which globalisation occurred, and today the Australian textile industry imports and exports along the entire value chain. For example, the ‘spinning industry’ (spinning of fibres into yarn for weaving or knitting fabric) is almost non-existent in Australia today compared to 30 years ago. Another trend associated with the changing landscape of the value chain is the concept of ‘offshoring’. Offshoring is when an organisation sends certain functions overseas, often to countries where labour is cheap in order to cut costs. Offshoring has been facilitated by IT and telecommunications development, allowing those offshore to communicate and operate easily with their foreign counterparts. Often it is the support functions of an organisation which are subject to offshoring, including human resources (HR), customer service (call centres) and finance. To a limited degree, core activities of an organisation have also been subject to overseas relocations. Fifarek and Veloso (2010) discussed this in regard to innovation activities, such as R&D, as they are more frequently being redistributed to global locations. There has been an increasing geographic dispersion of R&D despite its status as a more highly valued component of the value chain. However, highly technological R&D remains prominent in high-income regions, with more offshoring occurring with low technological R&D work where cost reductions outweigh the value of potential developments. Offshoring comes with many challenges as it also exposes the organisation to the many external forces of the offshore destinations. Another option for organisations is to completely outsource components of the value chain. This decision may be in order to optimise current operations, or due to changes in the value chain that require capabilities not currently available within the organisation. Not surprisingly, the types of capabilities often outsourced include technology. Technology insight 2.1 provides some data on IT outsourcing. TECHNOLOGY INSIGHT 2.1 IT Outsourcing A recent study found that many companies are outsourcing their IT budgets, with the total percentage of IT budget being spent on outsourcing increasing from 9.4% in 2018 to 12.7% in 2019 and 34% of companies now outsourcing some of their network operations (Sprouse 2019). This could be for various reasons, but it is likely companies are simply becoming more comfortable with outsourcing IT functions and perhaps realising that their own IT capabilities cannot keep up with the pace of technology as well as specialist providers can. Interestingly, small companies are adopting cloud technology faster than large companies, and are often used as indicators of changes in technology use. Cloud-based computing is particularly attractive to smaller businesses as they can avoid the potentially substantial cost of buying IT infrastructure and people to run it While application development accounts for 56% of outsourced IT functions, other areas for outsourcing include application maintenance, data centre operations, database administration, desktop support, disaster recovery services, help desk services, IT security, network operation, system implementation/ integration and web operations. 86 Global Strategy and Leadership Leaders and managers need to consider the risks and benefits before deciding to offshore or outsource components of the value chain. They need to ensure that the organisation has the capabilities to manage the change and to address any potential challenges associated with it. QUESTION 2.4 Consider the value chain in the pharmaceutical industry (see figure 2.11). Explain which of these components could be taken offshore or outsourced. Explain the advantages and/or disadvantages of this change. INDUSTRY SEGMENTATION Once the industry and its value chain have been defined, the industry can then be broken down into segments. Segmentation refers to breaking things into groups based on their characteristics. Typically, segments are based on the characteristics of products or services offered, and there can be several of these within an industry. As with industry definition, segment definition is often a function of the availability of data to analyse. However, this analysis often reveals important insights into industry trends, as most segments grow at different rates and have different profitability profiles. Analysing and understanding this data provides information to support the external and industry environment analysis. Figure 2.12 provides an example of particular product segments that exist within the retail clothing industry. Some organisations may choose to be involved in all segments within an industry, while others may focus on only one. A disruption in an industry can also lead to the introduction of completely new segments. An example would be the ‘ride-sharing’ segment of the transport industry. FIGURE 2.12 Segmentation of the retail clothing industry Accessories: 12.0% Infants’ apparel: 6.9% Childrens’ apparel: 10.7% Women’s apparel: 49.6% Men’s apparel: 20.8% Source: Data from IBISWorld 2018. When analysing a segment the type of information needed includes: segment definition — what it does and does not include total segment size — volume and value broken down where appropriate average annual growth rate for the past five years (10 years if possible) — preferably, this should be real growth (after inflation has been taken out, if this figure is known) long-term potential — competitive and disruptive forces that may impact long-term viability an explanation of the data. Industry segmentation analysis allows the organisation to clearly understand the industry within which it operates, its profitability and growth potential as well as its long-term viability. Example 2.4 examines one segmentation approach to the Australian domestic airline industry prior to the COVID-19 crisis. MODULE 2 Understanding the External Environment 87 EXAMPLE 2.4 Segments in the Australian Domestic Airline Industry By late March 2020, the federal government had committed AU$715 million to prop up Australia’s airline industry, crippled by the closing of national and even state borders as part of international efforts to manage the COVID-19 crisis. Even so, Australia’s second major airline Virgin Australia approached the federal government seeking a AU$1.4 billion bailout. Qantas, having taken a AU$1.05 billion loan secured against its fleet of planes, was not seeking a bailout, but said to keep the competitive landscape even and fair, such a bailout for Virgin would need to be matched by a loan to Qantas of AU$4.2 billion. This figure reflected the relative revenues of the two airlines. The Australian domestic airline industry can be regarded as a duopoly of these two companies. Qantas also owns and operates budget carrier Jetstar. Virgin Australia also owns and operates budget carrier Tiger Air. A number of small airlines service particular routes in regional Australia and do not directly compete with the major players. Regional airlines had been significantly affected when the downturn in the resources sector led to a decrease in demand for flights by FIFO workers. This was exacerbated by the COVID-19 crisis, and the federal government was forced to intervene to save the regional airlines and thus secure the future of air services in regional Australia. Table 2.1 lists a selection of the licensed airlines operating at the end of 2019. TABLE 2.1 Australian domestic airlines Home state Airlines Northern Territory Airnorth Fly Tiwi Hardy Aviation Queensland Alliance Airlines Fly Corporate Hevlift Australia Hinterland Aviation Pacific Air Express Qantas Skytrans Sunstate Airlines Toll Aviation Virgin Australia West Wing Aviation South Australia Cobham Aviation Services Australia New South Wales Airlink Eastern Australia Airlines Express Freighters Australia Fly Pelican Pel Air Qantas Qantas Freight Regional Express Airlines Sydney Seaplanes Tasman Cargo Airlines Toll Aviation Virgin Australia Victoria Jetstar Airways King Island Airlines Qantas Qantas Freight Regional Express Airlines Sharp Airlines Tigerair Australia Virgin Australia 88 Global Strategy and Leadership Western Australia Maroomba Airlines Network Aviation Skippers Aviation Virgin Australia Regional Airlines Tasmania Par Avion Skytraders Beyond the major operators and regional airlines, small operator Airly’s business plan focuses on subscription-based private flights — payment of a monthly fee entitling customers to unlimited flights on several important domestic routes. This innovative business model appeals to corporate travellers seeking to minimise the time involved in air travel — it is much quicker to board and disembark private flights. Industry Segmentation There are various ways to segment an industry. One useful way to understand the Australian airline industry is to segment it according to the type of service offered. For example, on the left of figure 2.13, the industry is segmented by passenger, freight and other services. On the right side, the passenger segment is further broken down into budget-fare and full-fare segments. FIGURE 2.13 Industry segmentation of the Australian domestic airline industry Supplementary Supplementary services: 7.8% services: 7.8% Freight: Freight: 2.6% 2.6% Passenger: 89.6% Full-fare passenger: 67.0% Budget-fare passenger: 22.6% Source: Data from IBISWorld 2018. It can be seen from figure 2.13 that most industry revenue arises from passenger transport. A small amount arises from freight and supplementary services (e.g. booking fees and in-flight catering). Each segment has unique characteristics. Full-fare passengers services are often the choice of business travellers seeking convenience, the ability to change flights and the overall higher level of service. Operators have reduced capacity dedicated to business travel over the past several years even though business travel itself has grown. The profitability of the segment per passenger has grown, but the decline in capacity means revenue overall has decreased. The budget segment targets money-conscious personal travellers. The major operators Qantas and Jetstar have targeted this segment with their Jetstar and Tiger Air operations respectively. The budget carriers tend to charge extra for things that are included in the full-fare segment (e.g. choice of seat and on-board drinks and meals). They also minimise costs by having less variety in aircraft — thus reducing maintenance and parts costs. The freight sector competes with road and rail freight services. It often carries time-sensitive, high-value goods. QUESTION 2.5 Which segment(s) do you think Airly’s business model would impact on the most? Why do you think this? What do you think the impact will be? THE INDUSTRY LIFE CYCLE As introduced in module 1, most industries have a life cycle — the industry life cycle goes through a start-up phase, a growth phase, a maturity phase (usually by far the largest phase), a shake-out and a decline phase. However, many industries tend to renew themselves and regrow through the use of different technologies, new strategies and product and service innovation, rather than decline. This distinguishes the MODULE 2 Understanding the External Environment 89 industry life cycle from a product life cycle (in which specific products and services tend to eventually enter terminal decline). The life cycle position of the industry is an important factor in formulating organisational strategy, so it is relevant to understand the life cycle stage of the industry. Different strategies are required at different points in an industry’s life cycle phase or stage and, as mentioned in module 1, different styles of leadership and management are also often required at each of the stages. Throughout the life cycle, the structure and environmental and competitive forces that influence an industry change. As such, an organisation needs to be adaptable. Figure 2.14 summarises the impact on the industry of these strategies against the industry life cycle, which are explained in more detail in the following sections. FIGURE 2.14 Industry life cycle Revenue $ Cash Proﬁt Start-up Growth Maturity Shakeout Decline or renewal Industry life cycle Source: Adapted from WE Rothschild, 1993, Risktaker, Caretaker, Surgeon, Undertaker: The Four Faces of Strategic Leadership, John Wiley & Sons, New York, figure 3.1, p. 32. Start-Up In the start-up phase, the industry is new and there are few competitors, and nor is there any threat of substitutes. The power of buyers is low because there are few alternatives. The power of suppliers, however, is relatively high as the industry is yet to have a significant impact. Typically, at this point of the life cycle, there will be many different visions (from the organisations) as to how the industry will develop and many different approaches to the industry, in terms of product type, features, performance and target markets. In the introduction stage, leaders and managers need to be innovators. They need to be nurturing relationships with both suppliers and early adaptor buyers. Resources are often limited and need to be invested in R&D. This often leads to negative cash flow as they aim to build market share at the expanse of short-term profitability. The organisations that optimise this phase often become leaders in the industry. An example of an industry in its introduction phase is Internet of Things (IoT). This industry allows a network of automated devices to work together to turn a normal house into a ‘smart’ home. This industry provides exciting opportunities for both new organisations and existing ones to expand the products and services offered. Lighting, thermostat, home security, appliances and even toilet seats can be modified to use ‘smart’ technologies and connect to a home network. Growth Once an industry becomes established and grows rapidly, it enters the growth stage. This phase sees a surge in new competitors, as new players enter the growing industry. As they are yet to gain market share, however, rivalry is low. The power of buyers is still relatively low as there is a supply shortfall — that is, demand still exceeds supply. High-growth rates enable most organisations to survive. Although cashflow improves at this stage, cash remains short as funds are needed for investment to cater for the high-growth rates and expansion plans. Leaders and managers will be primarily concerned with keeping up with current demand, not looking towards the future. Because the industry is growing quickly, competitive differentiation is not of critical importance at this stage and there is ‘enough room for everyone’ in the industry. However, now is the time 90 Global Strategy and Leadership for the leaders and managers to support product expansion and improve distribution in order to position themselves for the more competitive landscape of the mature stage. The ride-share industry is now in its growth stage in Australia with annual growth over the past five years of 51.7%. The number of businesses in the industry has also grown by over 50%, with Uber now joined by other organisations such as Ola and Bolt. Uber, as the first mover, has since expanded into new territories and new segments with UberEats (IBISWorld 2019). Maturity As growth rates reduce towards more normal rates, the industry enters the maturity stage. Rivalry is intensified, and some companies may consolidate through mergers. During the maturity phase, supply will start to match demand (supply reaches the level of demand). As such, buyers will start to have greater power than before. This is the stage in which a majority of industries stay for most of their lives. Customers become more knowledgeable and demanding and not all of the original products, organisations or strategies will survive. At this stage, cash flow should be positive. Leaders and managers focus on efficiency, cost control and market segmentation. Strategic management concepts come to the fore in this stage as it is no longer a case of simply producing to meet ever increasing demand. Strategies are developed to defend market position and maximise profits. The sportswear industry can be classified as mature. Although new products are constantly being developed by key players in the industry such as Nike and Adidas, this is to penetrate more of the existing market, rather than ‘grow’ with the rest of the industry. Shake-Out It is inevitable that a shake-out stage will occur. This stage is characterised by a plateau and a possible decline of growth and profitability in the industry. Many organisations in this stage will leave the industry due to their low returns, thereby reducing rivalry and competitiveness. The remaining, small group of organisations then dominates the industry, through mergers, acquisitions and takeovers, dominating with their own products. It becomes imperative that organisations in this stage protect their positions and maintain profitable operations. The challenge for leaders and managers at this stage is whether to leave or stay and defend their position. Both options are viable and depend on what is happening in the external environment as well as the organisations’ own capabilities. The retail industry is going through this phase at the moment with the of many stores closing and going into liquidation and large chains consolidating and closing low performing stores (New Daily 2019). 2019 saw the closure of Jeanswest, TopShop, Ed Harry, Napoleon Perdis, Gap, Esprit, ToysRUs, Roger David and Shoes of Prey in Australia alone. Many retailers who have survived are consolidating and closing unprofitable stores (EB Games closed 19 stores in January 2020, while Harris Scarfe and Bardot plan to close 21 and 58 stores respectively during 2020). The rise of online shopping (a new, disruptive segment within the industry), has challenged the traditional bricks-and-mortar model of retailing. This coupled with a new ‘discount driven’ focus of customers has made it difficult for all retailers to remain competitive. Decline or Renewal The industry enters the decline stage once growth and profitability are in clear decline. The threat of substitutes at this stage is not only high, but can also be a catalyst for an industry’s decline. At this time, a large number of organisations may leave the industry as the return on investment (ROI) is unsatisfactory. Domination of the industry by a few large competitors no longer yields sufficient returns and even these companies leave the industry. The industry’s products or services may no longer be useful to consumers as they have been replaced by newer technology. Consider an abacus-manufacturing industry that lost product relevance when slide rules and calculators were invented. There are still companies that make the abacus today, but the industry is very small and has been in decline for a very long time. If the industry enters the decline stage — and here industry life cycles differ from product life cycles in that industries survive for much longer than any individual product as technological changes enhance industry products — the full use of strategic management concepts becomes even more important to the leaders and managers as they decide how to maintain a unique position in a win–lose environment. Sales for one organisation can only be achieved at the expense of other organisations in the industry, unless profitable new niche opportunities are found. However, an organisation’s strategy is about being creative, not simply following others in the same industry. Consequently, even in declining industries there

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